Are we heading into another recession?

Traders at the New York Stock Exchange listen as Federal Reserve Chair Jerome Powell is seen on a video screen giving a news conference from Washington after the Fed announced a rate increase, Wednesday, Dec. 19, 2018. (AP Photo/Mark Lennihan)

As 2018 comes to an end, chaos and uncertainty coming out of Washington have led some economists to warn of a possible recession in the new year. Developments over the Christmas holiday fueled those fears.

The White House threatened a lengthy government shutdown lasting into January. President Trump repeatedly attacked the chairman of the Federal Reserve who has raised interest rates four times this year. Treasury Secretary Stephen Mnuchin met with top banking executives generated new worries of financial instability.

Those factors, plus an ongoing trade war with China, projections of a slowdown in the global economy and political instability around the Trump administration and Congress, precipitated a very un-merry Christmas on Wall Street.

Markets closed Monday posting double-digit losses from their recent highs. The Dow Jones industrial average and Nasdaq composite index had their worst Christmas Eve on record and the S&P 500 fell 2.7 percent, the worst pre-Christmas drop since 1931, at the height of the Great Depression.

The selloff continued outside the U.S. on Christmas Day. By Wednesday, the markets rallied, clawing back losses from earlier this week and the Dow saw its largest point-gain in history.

With political and financial volatility that had some investors reaching for an air sickness bag, the White House and others argued that the fundamentals of the U.S. economy remain sound.

The Federal Open Market Committee projected the U.S. economy will end the year with 3 percent growth in gross domestic product, the highest rate in over a decade. November marked the 98th consecutive month of job growth and workers' wages are gradually increasing.

Consumer confidence remains high and according to Mastercard, holiday retail sales hit record levels, up 5.1 percent over last year.

Aside from market "jitteriness," the White House has pointed to a strong underlying economy that shows no signs of weakening. In a press call with reporters last week, CEA Chairman Kevin Hassett suggested: "the odds that we're in a recession right now are close to zero."

Many financial analysts have argued for months that the stock market has been overdue for a correction, which does not necessarily spell doom for the economy.

"There is a lot weighing on investor sentiment currently, including the Fed, the partial federal government shutdown, trade tensions and slowing in the global economy," explained Ryan Sweet, Moody's director of Real Time Economics. "Despite all the turbulence on Wall Street, the U.S. economy’s fundamentals remain solid."

He clarified, "This isn't 2008."

Much of the growth President Trump boasted this year, both in the stock market and the economy, has been called a "sugar high." The Trump administration's $1.5 trillion tax cut made more cash available to many employers and consumers. Before that, the Fed's zero percent interest rate policy fueled the expansion and, arguably, the recovery.

That flow of low-interest, easy money began to slow in 2015 and dry up after Trump appointed Jerome Powell to head the Federal Reserve, a selection the president says he now regrets.

Amid historic market losses and speculation that Trump wanted to fire the Federal Reserve chairman, Kevin Hassett told The Wall Street Journal Wednesday that "Jay Powell's job is 100 percent safe. The President has no intention of firing Jay Powell."

In a tweet Monday, Trump stated that "the only problem" with the U.S. economy is the Federal Reserve. "They don’t have a feel for the Market, they don’t understand necessary Trade Wars or Strong Dollars or even Democrat Shutdowns over Borders. The Fed is like a powerful golfer who can’t score because he has no touch - he can’t putt!" the president wrote.

Presidents often take the credit and blame for the direction of the economy. Trump accepted credit when the markets were posting record highs throughout the first year and a half of his presidency and seemed to defy logic by shifting the blame to Powell and the Fed when those gains were erased in recent months.

Still, there is strong evidence that the Federal Reserve's policies are cutting into an otherwise positive financial and economic outlook.

Don Fishback a financial analyst and expert in probability and volatility warned, "An economic crisis is looming if the Fed doesn't stop its ill-advised path of raising rates and reducing its balance sheet."

The market selloff began in October after Powell announced plans to continue raising interest rates in 2019. The losses over Christmas were immediately precipitated by Powell's announcement last week of two more rate hikes in the new year, which would bring interest rates to the "normal" range of 3 percent.

Fishback argued that the Fed had an opportunity to raise rates when markets were soaring, immediately after Congress passed the 2017 Tax Cuts and Jobs Act. "But they waited too long," he said.

Rising interest rates are likely to lead to slower GDP growth in 2019 but will not likely result in a new recession, according to Sweet. Political factors within the president's control may prove more consequential.

For every week the partial shutdown is in effect, Moody's estimates it will cost the economy about 0.04 percent of GDP growth. Additionally, the ongoing trade tensions between the U.S. and China, continue to worry producers and investors.

If Trump wanted to boost investor sentiment, Sweet noted, "a dovish Fed may help temporarily, but an end to the trade tensions with China would be more significant."

Moreover, the president's criticism of the independent central bank could end up backfiring. "Policymakers faced with a close call on whether to hike rates could lean hawkish just to be sure they are not seen as being politically influenced," he advised.

What started in 2009 with the Obama administration's stimulus package, a $700 billion Wall Street bailout and virtually zero percent interest rates, is said to be the longest running recovery in modern history.

Despite arguments from the Obama and Trump administrations that the U.S. economy has gotten back on track, economist and president of the libertarian Mises Institute Jeff Deist argued it is "absolutely" headed for another recession based on the fundamentals, not the behavior of the president.

"Political instability in Washington plays a lot less of a role than advertised," he said, noting the record-breaking market gains all took place amid ongoing chaos at the Trump White House. "The bottom line is, since 2008 we haven't addressed the fundamental structural problems in the economy, which is too much debt."

Beginning in 2009, the Federal Reserve's zero interest rate policy created tons of new credit. At the same time, it also created tons of new debt.

American companies now have more bond debt than a decade ago, individuals have higher mortgage, credit card and student loan debts and the government has upward of $21 trillion in debt, more than double what it was in 2008 at the time of the crash.

The Fed's low interest rate policy created a "false sense of prosperity," Deist noted. Borrowing increased, which in turn stimulated record-breaking growth in the stock market, housing prices rebounded and consumer spending is at a high.

"The question is whether it's real," he continued. In other words, whether the conditions of prosperity would have existed without the Fed's stimulus and growing debt.

The answer to that question will become clearer in the coming months, as the Fed plans to continue raising interest rates.

"We’re about to see if the economy can continue on as it has been without this morphine in its system," Deist said. "I'm afraid the answer to that is no. I think we're going to find out that a lot of this presumed growth in the economy since 2008 has really been artificial."

close video ad
Unmutetoggle ad audio on off